Does Co-Signing a Mortgage Affect a First Time Home Buyer? Everything You Need to Know!
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While helping close family and friends whenever possible is a noble way to operate, it’s crucial to avoid putting yourself in a bind in the process. And that’s just what can happen when you co-sign a mortgage. Alongside the financial risks of assuming someone else’s debt, the mark on your credit could affect your benefits as a first-time home buyer.
Understanding the risk is essential when considering co-signing, no matter who you’re helping. We’ll explore how critical first-time home buyer benefits could be one of the many privileges you sacrifice by co-signing a mortgage.
How Does Co-Signing Work?
Co-signing occurs when you use your credit and finances to back a mortgage, thus helping another person improve their chances of buying a home. Lenders research your debt-to-income (DTI), employment history, and the same essential points as the primary borrower to approve you for the mortgage. At the closing, co-signers must sign off on loan documents.
Sometimes called a non-occupant co-borrower, a co-signer doesn’t live in or use the home to their advantage. They can’t have any stake in it, so you can’t look to your contractor or real estate agent as a possible co-signer to close on a house.
In nearly every instance, co-signers are spouses, domestic partners, or family members. Most loan types are more open to co-signers with familial ties. Regardless, the co-signer must be trustworthy, as they assume the responsibility to make payments if the primary borrower defaults.
Risks of Co-Signing
No matter how much you trust the other person to pay their mortgage, 30 years is a long time. There’s no telling what could happen to stop the primary borrower from maintaining their obligation. Some may be irresponsible and fail to pay on time, but even the most honest borrowers could suffer accidents or other setbacks that damage their income and ability to pay for a home.
Co-signing a mortgage carries several risks that can often outweigh the emotional benefits of helping a family member. A few of the essential hazards of co-signing a mortgage include the following:
- Damaged credit if the borrower fails to pay on time
- Increased DTI that could affect future borrowing
- Potential for the debt going to collections, wage garnishments, and lawsuits
- Initial hard credit inquiry
The one silver lining to being a co-signer is the credit boost you’ll enjoy if the borrower develops a strong history of paying on time. But as a co-signer, you won’t have much recourse if they don’t stay on top of the loan. The payments end at the co-signer, giving them neither the option to remove themselves from the mortgage without the borrower allowing it nor assume ownership of the property since their name isn’t on the title.
Does Co-Signing a Mortgage Affect a First-Time Home Buyer?
Co-signing a mortgage can affect a potential first-time home buyer. The initial hard credit hit, increased debt, and updated credit report reflecting a home loan can impact your ability to get unique benefits such as certain loans and down payment assistance. Your particular benefits will vary by location, as state and local governments also offer first-time buyer programs.
USDA, VA, and some conventional loans have unique borrower requirements, but being a first-time buyer is rarely one of them. The only requirement for an FHA loan, one of the most popular and beneficial mortgage types for first-time buyers, is that it must be for a primary residence. You can still qualify for an FHA loan even if you co-signed on another property because you don’t live there.
Credit and Debt-to-Income After Co-Signing
While your status as a co-signer won’t always affect your ability to get certain first-time benefits, the hit on your credit and DTI could play a role, especially if you plan on buying a home shortly after co-signing for someone else. FHA loans, in particular, carry a general 12-month rule to get around the DTI issue, which can be significant when you co-sign a loan for a few hundred thousand dollars.
If you want to buy your first home after co-signing on another mortgage, there are two instances where your DTI won’t count against you for an FHA loan application:
- You can prove that the lender won’t go after you for the debt if the borrower doesn’t pay
- You can prove that the borrower has made 12 consecutive on-time monthly payments
The initial hard credit inquiry, which can stay on your report for up to two years, will also generally stop being significant after 12 months. If you intend to co-sign a mortgage, consider your plans to buy a home later and how those red marks will affect your approval odds, amounts, and rates.
How to Protect Yourself When Co-Signing a Mortgage
Talking with a real estate attorney or the loan officer before co-signing a mortgage is critical. Discuss the underwriting requirements and tell them about your desire to use first-time buyer programs when the time comes. Research available first-time home buyer discounts, credits, and rates in your area, and ask how your status as a co-signer will affect eligibility.
If you decide to co-sign after discussing your first-time buyer benefits, you still have to protect your image for potential lenders. Even if you protect your first-time status, the credit hits from missed payments, defaults, or foreclosures will severely impact your ability to get financing. Here are a few ways you can keep yourself as informed and safe as possible as a co-signer:
- Request updates from the lender on any missed payments
- Ask for access to loan statements
- Keep a reserve fund to cover one or two missed payments
- Maintain consistent communication and a positive relationship with the borrower
- Determine an agreeable passage of ownership if the primary borrower passes away
Planning an exit from the mortgage is also a wise idea. If the borrower is building credit, they won’t need you to back the mortgage forever. They may be able to refinance when their income or credit improves, allowing them to take on the entire debt. You can take your name off and remove any impact it may have on your approvals. It may even help you. Showing as a fulfilled obligation, getting off the loan could improve your creditworthiness.
Alternatives to Co-Signing
Under certain circumstances, co-signing a mortgage may not affect your home-buying experience in any way. But whether you plan to buy a home later or not, the risks are rarely worth it. A 2016 survey from CreditCards.com found that over a quarter of co-signers suffered credit damage, while nearly 4 in 10 had to pay some of the debt. Helping family and friends is fine, but you must be ready to absorb some of the drawbacks.
You shouldn’t feel sorry for declining to co-sign if you don’t feel comfortable weathering the risks. And co-signing isn’t the only way you can help a home buyer in need. Many loans allow cash gifts, which may make the difference in qualifying for a home. Rather than stay on the hook and tie up your credit for several years, helping with the down payment can be a safer way to help. You can also point first-time home buyers to local and state assistance programs.
Final Thoughts
Co-signing a mortgage is rarely worth the risk if you are still considering your first home. The benefits for first-time buyers are vast, but you can limit your options tremendously by holding another mortgage over your head. Follow these tips, have tough conversations, and find other ways to make your loved one’s home-buying dreams a reality. After all, there’s nothing wrong with helping them while helping yourself.
Featured Image Credit: David Gyung, Shutterstock
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